Auto dealers are "poster children" for the impact of the downturn on business values
"Don't trust historical earnings when doing the income approach for auto dealerships," warns Jim Alerding, speaking at BVR's webinar on Valuing Auto Dealerships. "The next year earnings and DCF issues, which depend on future earnings, are going to be the most pertinent." This presents a problem for appraisers with auto dealer engagements--market data, even from public companies like AutoNation and Lithium Motors, never mind past private transactions, are also questionable at this point. Volumes are down, even if margins have been maintained by current cost cutting. The presence of fewer dealers within each brand have compensated for loss of volume, and dealers have reduced costs to reflect this low volume. That helps maintain value.
Carl Woodward points out that some profits have stayed high because the LIBOR rate is so low and inventory is priced at an artificially low level. "That's not going to last for ever, so floorplan costs are going to go up for dealers in the near future." Valuators can't expect margins to hold up going forward.
Don't forget franchise values. Alerding points out that any of the income methods will likely miss out on franchise value--separate from goodwill. Goodwill is residual, though franchise rights are indefinite lived. Ironically, "you can have a positive franchise value even for a dealer who is losing money," said Alerding. So, without goodwill, the income approach can fool even the best appraisers--"the intangibles will get you," said Kevin Yeanoplos. "I've worked on dealers who are losing money, but some on is still willing to pay a good price to get the franchise."
Woodward says to watch exorbitant rents, particularly. Dealers haven't been able to downsize long, expensive lease obligations. A seller may want to hang on to real estate and lease it to the buyer, often with inflated expectations, "and this often will scare away the best possible acquirers."
Market data and the income approach may be risky for auto dealerships now, as pointed out, but Woodward comments that even the asset approach exposes appraisers to a bunch of problems, too. There are common liabilities and assets that need to be examined carefully. First, often books are closed fast enough so that major liabilities are not entered in correct periods. And, again, franchise value and intangibles might also be overlooked. Woodward also mentions that tax-affecting, if appropriate, for divorce valuations in your state can be a big factor.
Blue sky, some percentage of annual sales (between 0 and 10%, for instance) used to be a reasonable rule of thumb. Another, says Woodward, who doesn't support their use, is average gross margin times number of vehicles sold--so a dealer who sells 1000 vehicles at an average profit of $3000 is, "blue sky, worth $3 million." Qualitative adjustments are always required, and the pool of buyers makes a different. "The dealer across the street, if there is one, may pay a premium, compared to some one who's trying to come into the market."
What changes in the market are permanent? "A lot of the discussion I hear from industry leaders is that there's a new normal for car sales. Consumers will hold on longer," believes Yeanoplos. "Green cars are also a permanent change, compounded by investment in mass transit." Temporary changes need to be addressed in our analyses, but we can't ignore permanent structural changes. "We're in the world where brands can pull your franchise without much warning, and throw you out of the party," concluded Alerding.
Increased union presence, particularly in the west, locks in some liabilities for buyers. Another issue is that auto dealer real estate is likely to recover in value slower than other sectors, since "these building are generally single purpose, and there are more sellers than buyers," said Alerding.
Risk factors, margins, projections, and appraiser judgments have all changed. "It's not that different from other industries, but this one has been a poster child for economic upheaval."
Transaction data are becoming harder to find--particularly to measure franchise value. Most of the acquirers are so large that reporting individual transactions is now too small to be required by the SEC. "There is no good source I know of for separating out the value of franchise rights," says Yeanoplos. "The best you can do it call people who work in the business, like me," said Woodword. "I do a lot of valuations in this area, and I still check with others when I hit complicated issues."